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India: Changing The Mix

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The Reserve Bank of India wants foreign banks operating in India to convert into wholly-owned subsidiaries and enjoy “near-national” treatment.

As many as 40 international banks, including Citibank, HSBC and Standard Chartered, already operate in India. Under the new regulations they will be asked to incorporate within India or operate as wholly-owned subsidiaries. Those that choose to incorporate will be given “near national” treatment, RBI officials say.

That means relaxed restrictions on the number of branches they can operate in India. Incorporating will also enable foreign banks to expand the range of their activities by raising new capital or possibly acquiring domestic banks.

But by operating as “near-national” banks, foreign banks will also have to abide by domestic bank mandates, bank officials noted. They will be asked to open branches in rural areas and also allocate as much as 40% of their consumer loan portfolio to low-income borrowers as well as agricultural workers.

Raghuram Rajan, the recently appointed governor of the RBI, wants India’s banking sector to play a more dynamic role in “broadening and deepening financial markets and increasing their liquidity and resilience.”

The central bank can play a key role in “expanding access to finance to small and medium enterprises, the unorganized sector, the poor, and remote and underserved areas of the country through measures to foster financial inclusion,” Rajan noted at an RBI meeting in October.

Still, the decision to expand the role of foreign banks within India’s economy hasn’t come easily. Rajan’s hand may have been forced by the fact that domestic banks—both state-owned and private banks—have performed poorly in recent years. The ratio of nonperforming assets to total assets now stands at more than 2%, twice the level of 2007–2008. And with the Bankex Index—the index of India’s listed banks—down more than 20% in 2013, the ability of domestic banks to attract new capital is greatly diminished.

India has enough money to pay for all of its short-term debts tomorrow if it needed to, as it has reserves that are equal to 15% of GDP, says Rajan. But asking domestic banks to be pro-active in helping expand the financial economy simply hasn’t worked. Asking foreign banks to step up doesn’t only bring needed capital, says Rajan, it also convinces investors that “India isn’t in danger of crisis.”